If you’re intrigued by the concept of smart beta, consider these exchange-traded funds. Thinkstock By Steven Goldberg, Contributing Columnist April 21, 2016 Investors have been flocking to index funds, both mutual and exchange-traded versions, in ever-increasing numbers. In doing so, they’ve yanked tens of billions of dollars out of actively managed funds, which try to beat an index and normally charge more than unmanaged index funds.See Also: How to Buy 7 Great Load Funds Without Paying the Sales Load But a hybrid type of fund—part index fund and part actively managed fund—is also making a bid for investor assets. Whether they’re called “smart beta,” “strategic beta” or one of several other names, you’ll want to understand them. Some are good investments. What’s smart beta (the term I’ll use for simplicity’s sake)? Index funds, such as those that track Standard & Poor’s 500-stock index, weight their holdings according to a security’s market value. In the case of stock index funds, holdings are weighted by market capitalization. A stock’s market cap, or value, is simply the number of shares outstanding multiplied by the share price. So the most popular stocks, the ones with the highest market caps, get the biggest weightings. In the S&P 500, Apple (symbol AAPL) has the biggest market cap, $612 billion, and consequently has the index’s biggest weighting, 3.4% of assets. (Figures are as of April 12.) Advertisement Smart beta mavens look at a capitalization-weighted index and ask, “Isn’t there a more intelligent way to select and weight stocks in an index than investor popularity?” They’ve come up with a cornucopia of ways to slice and dice the stock market to try to best conventional indexes. And asset-management firms have taken smart beta ideas and turned them into products, mostly exchange-traded funds, that track these rules-based indexes. The funds don’t pay generous salaries to managers and analysts to kick the tires of individual companies. Instead, the funds overweight stocks that academics have shown produce heftier gains historically or less severe losses than index funds. Smart beta funds charge a bit more than index funds but much less than most actively managed funds. Below are four types of smart beta funds, together with my favorites in each category. As with any type of fund, stick with those that charge the least. “Fees matter a lot,” says Alex Bryan, a Morningstar analyst. Value. Stocks that are cheap in relation to the underlying company’s profits, revenues, book value (assets minus liabilities) or other factors tend to provide healthier returns than other stocks. However, value, like all other strategies, can flounder for many years at a time. In fact, value stocks have badly lagged growth stocks (companies with above-average growth) since 2005. That makes this a good time to start building a position in bargain stocks because an investing style that has lagged for years often bounces back strongly. Advertisement Among value ETFs, my favorite is iShares MSCI USA Value Factor ETF (VLUE). Since the fund’s inception in mid 2013, it has, as you’d expect, lagged the S&P 500, by an average of 3.0 percentage points per year. It invests in cheap stocks, but it doesn’t overweight broad industry sectors. The ETF charges just 0.15% in annual expenses. Quality. I’ve been a longtime proponent of “high-quality” stocks, meaning companies with relatively high and stable earnings growth, low debt, and rising and sustainable dividend payouts. High-quality stocks tend to fall less than other stocks during bear markets, but expect them to lag in strong bull markets. One negative: Quality stocks have become so popular that they’re a little pricier than usual. Good quality ETFs include Vanguard Dividend Appreciation (VIG) and Schwab US Dividend Equity ETF (SCHD). They charge annual fees of just 0.15% and 0.07%, respectively. But my favorite fund for high quality is an actively managed one, Vanguard Dividend Growth (VDIGX). Manager Don Kilbride and his team put a strong emphasis on quality factors. The fund, a member of the Kiplinger 25, has beaten the two ETFs over the past three years, exhibits slightly lower volatility and, with an annual expense ratio of 0.33%, doesn’t charge much more than the ETFs. Low volatility. Don’t expect sizzling returns with low-volatility stocks in a hard-charging bull market. But low-vol stocks should do better in crummy markets. From my experience, most investors would accept that trade-off any day. My pick in this area is iShares MSCI USA Minimum Volatility (USMV). It doesn’t make huge sector bets, but it typically overweights health care, consumer staples and utility stocks. The ETF charges 0.15% per year. Advertisement Momentum. Newton’s law, believe it or not, tends to work with stocks. A stock that has gone up (or down) will tend to continue in that direction, at least for a while. I’m not a big fan of momentum strategies, but if you are, consider iShares MSCI USA Momentum Factor ETF (MTUM), which targets stocks that have posted good returns over the most recent six and 13 months, excluding the most recent month. That’s what the studies show works best. But almost all studies are based on back testing—that is, looking at how a particular strategy would have done in the past. The more complex a back test, (see the paragraph above), the less likely that the strategy will actually work. Want an ETF that employs all four of the strategies described above? Consider Goldman Sachs ActiveBeta US Large Cap Equity ETF (GSLC). Charging just 0.09% annually, the ETF makes modest bets using all four factors. I’d be surprised if it beat the S&P by more than one-half or one percentage point per year, but I’d be equally surprised if the fund lagged badly. Steve Goldberg is an investment adviser in the Washington, D.C., area. See Also: Vanguard ETFs vs. Vanguard Mutual Funds: Which Make for Better Investments?